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RW7eCh04.doc

27 Pages
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Department
Economics
Course Code
ECN 104
Professor
Vikraman Baskaran

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Description
CHAPTER 4LONGTERM FINANCIAL PLANNING AND GROWTH Learning ObjectivesLO1The objectives and goals of financial planningLO2How to compute the external financing needed to fund a firms growthLO3How to apply the percentage sales methodLO4The factors determining the growth of the firmLO5How to compute the sustainable and internal growth ratesLO6Some of the problems in planning for growthAnswers to Concepts Review and Critical Thinking Questions1LO1 The reason is that ultimately sales are the driving force behind a business A firms assets employees and in fact just about every aspect of its operations and financing exist to directly or indirectly support sales Put differently a firms future need for things like capital assets employees inventory and financing are determined by its future sales level2LO1 Two assumptions of the sustainable growth formula are that the company does not want to sell new equity and that financial policy is fixed If the company raises outside equity or increases its debtequity ratio it can grow at a higher rate than the sustainable growth rate Of course the company could also grow faster than its profit margin increases if it changes its dividend policy by increasing the retention ratio or its total asset turnover increases3LO2 The internal growth rate is greater than 15 because at a 15 growth rate the negative EFN indicates that there is excess internal financing If the internal growth rate is greater than 15 then the sustainable growth rate is certainly greater than 15 because there is additional debt financing used in that case assuming the firm is not 100 equityfinanced As the retention ratio is increased the firm has more internal sources of funding so the EFN will decline Conversely as the retention ratio is decreased the EFN will rise If the firm pays out all its earnings in the form of dividends then the firm has no internal sources of funding ignoring the effects of accounts payable the internal growth rate is zero in this case and the EFN will rise to the change in total assets4LO2 3 The sustainable growth rate is greater than 20 because at a 20 growth rate the negative EFN indicates that there is excess financing still available If the firm is 100 equity financed then the sustainable and internal growth rates are equal and the internal growth rate would be greater than 20 However when the firm has some debt the internal growth rate is always less than the sustainable growth rate so it is ambiguous whether the internal growth rate would be greater than or less than 20 If the retention ratio is increased the firm will have more internal funding sources available and it will have to take on more debt to keep the debtequity ratio constant so the EFN will decline Conversely if the retention ratio is decreased the EFN will rise If the retention rate is zero both the internal and sustainable growth rates are zero and the EFN will rise to the change in total assets5LO6 Presumably not but of course if the product had been much less popular then a similar fate would have awaited due to lack of salesS416LO6 Since customers did not pay until shipment receivables rose The firms NWC but not its cash increased At the same time costs were rising faster than cash revenues so operating cash flow declined The firms capital spending was also rising Thus all three components of cash flow from assets were negatively impacted7LO6 Apparently not In hindsight the firm may have underestimated costs and also underestimated the extra demand from the lower price8LO6 Financing possibly could have been arranged if the company had taken quick enough action Sometimes it becomes apparent that help is needed only when it is too late again emphasizing the need for planning9LO6 All three were important but the lack of cash or more generally financial resources ultimately spelled doom An inadequate cash resource is usually cited as the most common cause of small business failure10LO6 Demanding cash up front increasing prices subcontracting production and improving financial resources via new owners or new sources of credit are some of the options When orders exceed capacity price increases may be especially beneficialS42
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